I haven't filed a tax return in a long time – what should I know?
If you haven't filed a tax return for a while – you're not alone. There are literally thousands of people and small business owners who haven't filed a tax return in several years. The IRS is actively searching for millions of missing tax returns at any given time. The following are eight things you should know if you fall into this category:
First – Don't Lose Sleep About Jail Time
Willfully failing to file a tax return is a federal crime BUT there are only 3000 or so IRS indictments filed each year. Most people charged with failure to file a tax return have been charged with other criminal offenses and the un-filed return issue just gets dragged into the mix. The IRS just doesn't prosecute these cases very often. It takes the position as well… that if you file your returns before it begins the criminal process, they won't proceed.
Second – Beware the Automated Substitute Return Program
For most late filers, the real issue is the Automated Substitute Return Program (ASFR). The IRS “system” gathers information that has been reported about you from 1099s, w-2s, k-1s and create a rough return. The return contains just the reported income and a standard deduction for a single person. That rough return is sent to you with a warning. The warning essentially says that if you don't file the correct return within a certain period of time, the IRS will use the rough return as a determination of how much you owe and then start collection proceedings. Many late filers get these bills in the mail but don't open them out of fear, and then they wake up one day and a bank account has been frozen.
Third – The ASFR Will Almost Always Result in More Debt Than You Owe
You read above about how they do these returns and for most people, especially the self-employed, this process results in debts that are much larger than you actually owe. Sometimes it matches the correct amount but this is usually only when you are a w-2 wage earner with no itemized deductions, or family members. As a result of these very high and very fictitious numbers, many people can't even open the envelopes from the IRS – they get physically sick, can't sleep and lose the ability to move forward with the problem.
Fourth – You Can Challenge and Reduce the Amount Owed by Completing Correct Returns and Taking Some Other Steps
We have helped literally hundreds of individuals and self-employed complete corrected returns for years the IRS has already assessed ASFRs and convince the IRS to replace the ASFR with the correct return(s). This has resulted in millions of dollars in savings.
The IRS will almost always agree to replace the ASFR with the corrected return and in most cases it makes sense to do this.
Fifth – Sometimes it Makes No Sense to Challenge the ASFR
What? It may make no sense to try and reduce the debt? Follow me on this:
a. Statute of Limitations
It is possible that on a particular tax year the 10 year statute of limitations is going to be applied by the IRS. If the IRS assessed an incorrect debt based on it's ASFR in January of 2006 and it is going to apply the 10 year statute of limitations on collection to the debt in January of 2016 – it may not make any sense to spend your time, energy and money on the creation of corrected returns even if those returns would reduce the debt substantially.
b. Offer in Compromise
An IRS Offer in Compromise is a formal process that allows certain qualifying individuals and businesses to settle the debt for less than is “owed”. One of the factors in the IRS formula is the amount of the debt and strangely, the higher the debt…the better in most cases.
Sixth – The ASFR Once Assessed, Can Ruin Your Ability to Discharge the Debt in Bankruptcy
Right now the IRS treats debt from a return filed AFTER the IRS has filed and “assessed” one of these ASFRs as non-dischargeable in bankruptcy – ever, and right now the 9th Circuit Court of Appeals doesn't disagree. So imagine a realtor or other self employed person who had a string of good years and didn't file their returns. Imagine the ASFRs were created and assessed for those years and the debt with interest an penalty totaled the nice, round, large, sum of $400,000. Now suppose the person created correct returns that reduced the overall debt to $200,000.00.
Imagine that this person made too much money to qualify for an IRS offer in compromise BUT that the tax debt was the largest portion of his or her overall debt and as a result, they could use chapter 7 bankruptcy to discharge it after certain time periods and other factors were taken into account. (Grammar Police needed?)
Good scenario for them. Right? Not so fast.
ASFR assessed before he or she filed returns – the principal tax debt balance won't ever be discharged in bankruptcy at least in the 9th circuit. (Assuming the law doesn't change)
Seventh – If You Haven't Filed for More Than Six Years – It's Possible That You Won't Need to File More than Six Years
The IRS isn't going to deal with you if you have missing returns. It won't negotiate a payment plan or an offer in compromise and in bankruptcy certain years must be filed as well. The mistake people make is that they assume that if they haven't filed for 10 years, all 10 have to be filed. This isn't typically the case because in most cases the IRS only requires 6 years of missing returns if they haven't already done them for you.
On rare occasion it makes sense to file beyond the 6 year mark other than to challenge an ASFR. If you never file a tax return for a particular year, no statute of limitations period begins to run. The IRS can file that return for you forever, or charge you with a crime for failure to file…forever. Also, if you don't file it, you can't ever get the clock running for bankruptcy purposes.
I can't tell you how many times someone calls me who just filed 10+ years of missing tax returns creating thousands of dollars of unnecessary debt. If you are about to do this – talk to me first…please.
Eighth – Self Employed During Those Years and Don't Have Good Documentation? The Returns Can Be “Pieced” Together
The IRS has income histories for you several years back. The document that needs to be ordered is called a “Wage and Income Transcript” and it will show you everything reported income wise, mortgage interest wise and a few other items. You can use that and your old bank statements to re-create income.
Figuring out the missing information about expenses, especially small business expenses ,is often the more difficult problem. But if we know your income, we can often piece together your business budget from old bank statements and comparable expenses from similar businesses. The law requires a best guess based on a reasonable foundation. That can be built.
Search around our blog for more information, or simply call and ask for me directly. I will speak with you for about 15 minutes for free and answer your questions.